Shareholder Activism and Hostile Takeovers in Japan

Shareholder activism is on the rise in Japan. June is typically the busiest month for general shareholders’ meetings of listed companies in Japan, and this has been borne out by recent statistics indicating that a record number of 76 proposals were made at general shareholders’ meetings in June 2022. Japan ranks third in the world in terms of the number of companies in which activists invest. This reflects that general view among global and domestic activists that there are significant opportunities for unlocking the intrinsic value of Japan Inc.

Two major, but non-statutory “soft-law” developments are the main drivers of the recent resurgence of shareholder activism in Japan.

First, the 2014 Stewardship Code of Japan, amended in 2017 and 2020, which applies to institutional investors on a “comply-or-explain” basis, requires institutional investors to disclose their votes (and the rationale behind them) on proposals in respect of their investee companies. This has caused institutional investors to seriously consider the proposals of activist shareholders and resulted in a growing tendency on the part of institutional investors to vote in line with activist shareholders on proposals in a manner that is consistent with the voting policies of the institutional investors.

Second, the 2018 amendment to the 2015 Corporate Governance Code of Japan contains recommendations for listed companies to disclose their plans on reduction of cross-shareholdings (ie, the practice of listed companies holding shares in each other), a practice that is not in line with international corporate norms and therefore the subject of criticism from many international investors over the years. The Corporate Governance Code of Japan also recommends for the boards of listed companies to annually review and disclose, on an investment-by-investment basis, whether its holdings in another company should be sold based on cost-benefit and opportunity cost analysis. These developments in the corporate regulatory framework of Japan have brought about a decline in cross-shareholdings, thereby raising expectations among activist shareholders of greater success in pushing their proposals at shareholders` meetings of listed companies in Japan.

There has also been a notable change in the behaviour of activist shareholders in Japan in recent years.

Unlike the 2000s when aggressive activist funds that had purchased significant stakes in Japanese companies tried (and failed) to intervene in the management and strategies of their investees, activist shareholders now tend to acquire smaller stakes in investee companies, in addition to taking the less aggressive approach of informal communications on a one-to-one basis with the board and management members of their investees, by way of engaging them and gauging their appetite for proposed changes to their management and corporate strategies.

The range of target investees has also expanded over time. In the past, favoured companies tended to be small- and mid-cap companies. This has now changed, as exemplified by the investments of global activist funds in large organisations like Toshiba Corporation and Sony Corporation.

Moreover, whilst many activist shareholders continue to push for higher dividends or stock buybacks, the scope of shareholder activism has gradually broadened to calls for divestment of their investees’ underperforming or non-core businesses and even replacement of senior management members who are deemed ineffective. One of the highest-profile instances of a successful activist campaign in relation to a Japanese listed company was the 2018 campaign by US activist fund ValueAct Capital against the management of leading precision machinery manufacturer Olympus, which culminated in ValueAct Capital gaining seats on the board of Olympus, followed by the disposal of Olympus’ imaging business (in 2021) and scientific solutions business (targeted for completion by 2023).

Another prominent example of corporate activism in Japan involved Oasis Management, which recently set up a dedicated website to persuade the shareholders of Fujitec, a major elevator and escalator manufacturer, to vote against the reappointment of its incumbent representative director at its general shareholders meeting in June 2022. Oasis succeeded in its campaign when the board of Fujitec withdrew its resolution for the reappointment on the date of the general meeting.

The recent series of amendments to Japan’s Foreign Exchange and Foreign Trade Act (FEFTA), which lowered the threshold at which pre-notification of share acquisitions in listed companies in designated sectors is required from 10% to 1%, may impede investments by global activist funds in Japan. Nevertheless, based on the current trend of corporate restructuring among Japanese conglomerates, often involving the divestment of their ancillary businesses to enable greater focus on their core businesses, shareholder activism targeting Japanese companies for strategic overhauls is expected to continue. Furthermore, shareholder activism can be expected to extend to ESG matters in the coming years due to the growing prevalence of such concerns.

The number of hostile takeovers has continued to rise in the Japanese M&A market and 2021 saw a record eight hostile takeover bids, accounting for more than 10% of all takeover bids in Japan that year. Conversely, in part due to the imposition of more stringent stewardship responsibilities on institutional investors and the exercise of their votes, the number of listed companies that have taken advance defensive measures against possible takeovers is declining. As of July 2022, only 266 listed companies, or 6.9% of all listed companies in Japan, have taken defensive measures against takeovers. This reflects the difficulty in getting institutional investors to see the value of so-called “advance warning type” takeover defence measures and, consequently, getting them to vote for the implementation of such measures at general shareholders’ meetings.

Against this backdrop, there have been several cases of takeover defence measures being implemented by companies only after they encounter unanticipated hostile takeovers. These measures typically involve the free allotment of share options with exercise conditions and acquisition provisions that are discriminatory to the acquirer. Such actions have driven some prospective hostile acquirers to file petitions for preliminary injunctions against the relevant takeover defence measures, resulting in an accumulation of some significant judicial decisions in 2021.

A series of courts decisions in 2021, including the case involving Tokyo Kikai Seisakusho Ltd (TKS), demonstrated that hostile takeover defence measures approved at shareholders’ meetings can be valid even if they are implemented after an unanticipated hostile takeover is encountered. More specifically, the courts in Japan have confirmed that takeover defence measures based on “the will of shareholders” will be upheld if certain conditions are met.

In the TKS case, the Supreme Court of Japan affirmed in 2021 a judgment of the Tokyo High Court dismissing a petition for a preliminary injunction against takeover defence measures taken by TKS against a prospective acquirer who had amassed around 40% of the shares in TKS through on-market transactions, provided that the takeover defence measures had been approved by the shareholders of TKS at a shareholders’ meeting under a “Majority of Minority” vote (ie, a resolution passed at a general meeting of shareholders by a majority of the shareholders present who have no interest in the takeover, excluding the prospective acquirer and parties acting in concert with it, as well as the management and parties acting in concert with it). In the TKS case, the Supreme Court was satisfied that this condition had been met.

Allowing countermeasures against a hostile takeover on the basis of a resolution adopted at a general shareholders’ meeting may have the unintended consequence of disincentivising management shareholders or companies with high cross-shareholding ratios from fairly considering takeover bids that could potentially enhance corporate value. However, for companies with a high percentage of institutional investors seeking returns on their investments, the general principle of “the will of shareholders” would prevent value-enhancing acquisitions from being blocked by management out of self-preservation. On the contrary, the principle would incentivise management to achieve greater management efficiency in order to increase the value of the target and earn more trust from the market. As noted, the corporate governance reforms that have been set in motion since the 2010s have attracted more institutional investments in Japanese companies and discouraged cross-shareholdings. The time is ripe for the “the will of shareholders” to reap its intended benefits.

As is the case with judicial decisions in general, the specific circumstances of each case have a significant influence on its outcome. Accordingly, the scope of applicability of the series of judgments in 2021 related to hostile takeovers, including the TKS case, remains unclear. In the meantime, the legality of takeover countermeasures continues to be an important issue in the practice of corporate takeover defence and, accordingly, further developments in this area of law can be expected.